FDI, openness and income

This is an empirical study of the impact of foreign direct investment (FDI) on income. It presents cross-country evidence that inward FDI is positively correlated with income. In addition, an instrument for FDI is constructed to address the issue of endogeneity. The results show that instrumental-variables (IV) estimates of the impact of FDI on income are positive and greater than OLS estimates, similar to the findings on trade in Frankel and Romer (1999). The evidence in this paper suggests that inward FDI contributes to higher income, and favours the argument of Irwin and Tervio (2002) that trade openness is subject to measurement error - in particular, trade is an imperfect proxy for many income-enhancing interactions between countries.